Hotel Condominium Not a Security
A federal appellate court has reviewed a lower court’s dismissal of a lawsuit alleging that the sale of hotel condominium units constituted an investment contract and thus needed to comply with federal and state securities laws.
A group of individuals (“Purchasers”) who had individually purchased condominiums in the Hard Rock Hotel San Diego (“Hotel”) brought a class action lawsuit against the developer, operator, real estate broker, and other related entities involved in the sale and operation of the Hotel’s condominium units. The Hotel had 420 condominium units, in addition to commercial retail space. The condos were not registered with any agency as securities.
Following the purchase of their condo, each of the Purchasers signed a Rental Management Agreement (“Management Agreement”) with the operator of the hotel at later date. Even though the Management Agreement was a separate contract with a different entity than the developer who had sold them their unit, the Purchasers claimed that the Management Agreement was part of their purchase contract. The Purchasers argued that they were required to execute the Management Agreement and their expectations for a profit in their investment rested on the Management Agreement. They also alleged that they had no control over their units, not even possessing a key to their unit.
The Purchasers asserted that the purchase contract combined with the Management Agreement constituted an “investment contract,” and this investment contract did not comply with state or federal securities laws. The complaint also contained allegations of misrepresentation under state and federal securities laws, sought rescission of the contracts, and common-law fraud. The trial court dismissed the entire lawsuit on the grounds that the sale of the condominiums did not constitute a security, and the Purchasers appealed.
The United States Court of Appeals for the Ninth Circuit affirmed the trial court. The court first looked at whether a condo sale could constitute an investment contract and thus require compliance with securities laws. An “investment contract” is an investment of money in a common enterprise with an expectation of profit through the efforts of others. While real estate purchase contracts are not usually considered investment contracts, courts will examine the facts of each transaction to determine whether a particular transaction constitutes an investment contract and, in a prior case, the court had found that condo sales could constitute the sale of a security.
The court ruled that the Hotel purchase and the Management Agreement were separate agreements and therefore did not constitute an investment contract. In order for the condo sale to constitute an investment contract, the Purchasers would need to show that the two agreements were sold as a package and the Purchasers expected to receive investment-like profits from the investment through the purchase of a condo. Instead, the Purchasers had not demonstrated that they were even told about the Management Agreement when they purchased their condos and they had not executed the Management Agreement until 8 to 15 months after they had purchased their condo. Because the Purchasers had not shown that the two contracts were connected, they had failed to show that they were offered a security.
The court also determined that the Purchasers’ “economic reality” argument was not persuasive. The Purchasers argued that the only viable use of the condos was as an investment property with an expectation of profit, but as NAR pointed out in its amicus curiae brief, there was no reason that the Purchasers could only use the condos as a short-term vacation property. Since all of the allegations made in the complaint were based on the argument that the sale of the Hotel condos constituted the sale of a security, the court affirmed the dismissal of the lawsuit because the Purchasers had failed to demonstrate that their purchase constituted an investment contract.
Salameh v. Tarsadia Hotel, 726 F.3d 1124 (9th Cir. 2013).
Editor’s Note: Based on the recommendation of the Legal Action Committee, NAR submitted an amicus curiae brief with The Real Estate Roundtable seeking to uphold he trial court’s dismissal of the lawsuit.